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National Institute of Economic and Social Research

Friday, 15 February 2013

No debate please, we're Europeans

[Updated March 6, 2013. Mr Rehn's letter and this post sparked a lot of further debate/comment, in particular Karl Whelan's excellent Forbes piece here and Paul Krugman here and here. Apparently Krugman's comments, in particular, have irritated the Commission considerably, as the FT describes here. Mr O'Connor - Mr Rehn's spokesperson - doesn't exactly put up a strong defence, appearing to confuse the 1930s and the 1940s (I've asked him via twitter to explain what he meant). On the substance, I think Kevin O'Rourke says all that's needed.]I pointed out late last year that European Commission Vice President Olli Rehn has been predicting for at least two years that, thanks to the excellent policies recommended by the Commission and the European Central Bank, economic recovery in the crisis economies of the eurozone is imminent. However, this week - perhaps noting that outside the financial markets, the light at the end of the tunnel that he is fond of referring to appears to be receding - he's tried a different tack. Blame the economists - and in particular, economists who want actually to use proper, theoretically based and empirically grounded analysis to critique the Commission's policies. Mr Rehn, in a letter to European Finance Ministers, copied to other international financial luminaries like Christine Lagarde, says:

"I would like to make a few points about a debate which has not been helpful and which has risked to erode the confidence we have painstakingly built up over the last years in late night meetings. I refer to the debate about fiscal multipliers, ie the marginal impact that a change in fiscal policy has on economic growth. The debate in general has not brought us much new insight."

Much of the rest of the letter is devoted to Mr Rehn's (and presumably the Commission's economists) attempt to debunk the findings of IMF Chief Economist Olivier Blanchard, who found, to no-one's great surprise, that the adverse impacts of fiscal consolidation were indeed much greater than that forecast by the Fund or the Commission. I won't attempt a point by point rebuttal, but would note the following:

as I said here, it is quite true that on its own the Fund analysis doesn't demonstrate that the Commission and Mr Rehn (and here the Treasury, Bank and OBR) are wrong. But the whole weight of the evidence, both theoretical and empirical, does. Our estimates of the impact of self-defeating austerity are here.

while Blanchard's analysis is far from the end of the story, it is a professional piece of work by one of the world's leading empirical macroeconomists. The Commission's rebuttal, by contrast, would, as I say here, shame a first-year Masters' student. [Briefly, for nerds, including sovereign yields as a "control variable" for growth outcomes is so obviously misspecified - yields are an outcome, not an exogeneous independent variable - as to be a straight fail.]

But of course the really surprising thing is that Mr Rehn should be writing to Finance Ministers, and the IMF Managing Director, complaining that an academic paper on a very policy-relevant, but highly technical issue of empirical macroeconomics, represented "debate which has not been helpful". I'm not trying to get on any high horse about academic freedom; it just seems bizarre. The optimistic conclusion is that Mr Rehn recognises that the economic justification, tenuous at the best of times, for the self-defeating austerity policies pursued by eurozone policymakers is crumbling - and that, if authored by the IMF Chief Economist, even quite a technical paper (and, who knows, even blogs like mine) can make a major contribution to undermining it and, maybe, lead to pressure for more sensible policies. Let's hope so.

17 comments:

Rehn: "If one takes into account the deterioration of investor confidence expressed by rising government bond yields, the results of the multiplier analysis change...as shown in Box I.5 on p[age 41 of the Commission's autumn [sic] 2012 forecast."

I.5 from Autumn 2012: "Without questioning that fiscal multipliers are probably larger than usual at the current juncture..."

Mr. Rehn is mistaken about empirical examples too, for instance about the 'crowd funding' way the Belgians accidentally used to lower interest rates on government debt - just pass 'the markets' by: http://rwer.wordpress.com/2013/02/15/how-the-belgians-really-broke-the-repression-of-the-financial-markets/

This is the kind of reaction from officialdom that is is entirely predictable once policy-makers go down the road of relying on psychological channels to produce the effects they are trying to achieve. The efficacy of those expectation management channels, even in theory, depends on large numbers of market participants having certain kinds of background beliefs about the connections between things. The policy maker doesn't care whether those beliefs are well-grounded or not, only that people have them, because the beliefs are essential for their placebo cures to work. They are then going to get irritated when scientists come along and try to determine whether the beliefs are true, and publicize the results.

If Olli Rehn organises a garden party barbecue during the summer, and in the days before the weatherman tells him that heavy rain and gales are extremely likely, should the weatherman take some of the blame if all the guests get soaked, many catch pneumonia and the barbecue floats out of the garden on the flood?

Jonathan: I read Mr. Rehn's letter and conclude you are an optimist. All I could gather from Mr. Rehn's defensive letter was his profound belief in "confidence" as a driver of recovery. This approach is being twisted into a theory that we won't have a recovery because people and studies are questioning his policies; instead everyone needs to get behind these policies in order to maintain confidence. Hence, the failure of the recovery will be the fault of studies and bloggers that disagree with austerity because they undermined confidence. Economics has left the room.

I love your choice of header, because it reminds me of Finland's own banking crisis in the 1990s that austerian policies turned into a depression. What happened in Finland back then is that all the parliamentary parties formed a coalition government. This was meant to be a show of national unity as well as show the government's resolve (of which they had far too much, no doubt they would have tolerated 25% unemployment). Another unspoken effect of an all-encompassing coalition was "No debate please". The government set the parameters of the debate, which in a nutshell amounted to "there are no alternatives". If somebody tried to present alternatives to the government's bloodyminded policies they were effectively frozen out and branded as unserious. How it must rankle Olli Rehn he can't rely on such unity in the international community.

BTW at the time Mr Rehn was a member of the parliamentary Finance Committee and special assistant to the Prime Minister. He really hasn't changed at all, still peddling blood-letting as a cure.

This is not true insofar as there was no coalition government of all parties – only 4 of the 9 parties in the Finnish parliament participated in the government (including Rehn's own Centre Party) – but it is otherwise a correct description of the Finnish depression of the '90s.

An additional explanation is that countercyclical policies were never politically acceptable in Finland, even in the post-war golden age of Keynesianism. While the rest of the Western world quickly accepted them in the '50s and '60s, the political culture in Finland clung to the Treasury View and an almost religious cult of balanced budgets. The response to the '90s depression was just one episode in a long unbroken tradition of deep hostility to and suspicion of any kind of countercyclical policy.

So Finnish policymakers and Finnish public debate in general is quite bewildered by the recent revival in the fortunes of Keynesian thinking – because it's about restoring the reputation of something that simply never arrived in Finland in the first place (outside the economics profession, that is). And Rehn is as classically Finnish an economic policymaker as you can get.

Ah, my memory was off. The rainbow coalition came in 1995 when the worst was already over, i.e. the markka had been devalued and an export-led recovery had been chugging along for a while.

Austerity had always been the favored "medicine" but it had also been coupled with a devaluation of the currency. What made the equation impossible and led to a depression was the decision taken during good times to never ever devalue again because the Finnish markka had gained a bit of a bad reputation. Eventually a devaluation was forced by currency speculators but not before the government had done much damage through the double punch of austerity and defending the currency (fr.ex Bank of Finland raised interest rates into double digits in the middle of the depression to heed off speculators, which just beggars belief). Sure, it was also a banking crisis but that alone couldn't have led to 19% unemployment (17.5% using current EU standards). Sure we also lost our lucrative export market in the East when the Soviet Union collapsed, but that should have been the final signal that defending the Markka was a fool's game. Sadly, it took more than that.